Against the greening of central banks

Just because central banks can use their limited policy tools to pursue climate goals doesn’t mean they should. There are far more effective climate measures available to tax legislators and regulators, and central bankers already have enough on their plates.

NEW YORK – One way or another, central bank behavior will have to change because of the climate crisis, but it should change only because it will create new constraints and drive new forms of public and private economic activity. The primary role of central banks should not change, nor should they adopt “green” goals that could undermine the pursuit of their traditional goals: financial stability and price stability (which in the United States is a dual mandate of stability. prices and a maximum level of employment).

Climate change will be a defining global issue for decades to come, as we are still extremely far from achieving a low-carbon and resilient world. There are three factors in our greenhouse gas (GHG) emissions that will prevent an adequate response.

First, the benefits (cheap energy) are enjoyed in the present while the costs (global warming) will have to be paid in the future. Second, the benefits are “local” (for the GHG emitter), while the costs are global: a classic externality. Third, the most effective methods of limiting GHG emissions impose disproportionate burdens on developing countries, while the task of compensating them remains politically weak.

The most effective way to address the externalities of climate change is with targeted fiscal and regulatory measures. Pigouvian taxes or tradable quotas could create the right incentives to reduce GHG emissions. Carbon taxes, such as those promoted by William D. Nordhaus of Yale University, must become the global norm (although it is difficult to envision a global carbon tax working without a significant transfer of wealth from developed to developing countries ).

Green taxes and fees could be supplemented by rules and regulations that target energy use and emissions, and public spending could support the research and development of the green technologies that we will need.

However, a green mandate for central banks is not part of this recipe. It is true that legal mandates can change, and central banks have a long tradition of exceeding them.

The financial stability mandate of the European Central Bank is secondary to – “without prejudice to” – its price stability mandate. This did not prevent it from acting decisively and quite effectively in the current global financial crisis, the eurozone sovereign debt crisis and the Covid-19 crisis, even if that meant exceeding the price stability target in 2021 and probably also that of 2022. Furthermore, Article Three of the Treaty on European Union explicitly stipulates “a high level of protection and improvement of the quality of the environment”, so it is easy to see how the instruments of financial and monetary stability of the European Central Bank could be used to tackle climate change.

But that doesn’t mean they should be used that way. Standard monetary policy instruments (one or more interest rates, the size and composition of the central bank’s balance sheet, forward-looking guidance, and control of the yield curve) are often used to target the stability of prices or double mandate. The results show that there is no room for maneuver in the arsenal of monetary policy measures.

These monetary policy instruments affect financial stability as well, and not always in desirable ways. In addition, liquidity and capital requirements underpin micro and macroprudential stability, and central banks may impose additional conditions on the size and composition of the balance sheets of regulated entities. As a creditor and market maker of last resort, the central bank can choose its eligible counterparties, the instruments it accepts as collateral or is purchased outright, and the terms and conditions under which it makes loans and makes direct purchases.

Climate change undoubtedly affects a central bank’s price stability objective, for example, through current and anticipated changes to aggregate demand and supply, energy prices, and other channels. It could also significantly alter the transmission of monetary policy, having to become an integral part of the models that guide central banks in pursuit of their primary objectives.

Ecological problems also significantly affect price stability. Extreme weather events can damage the resources of financial institutions and their counterparts. Climate mitigation and adaptation initiatives can reduce the value of assets, leaving many of them “stagnant” or undervalued. The financial stability mandate of a central bank requires it to recognize and respond appropriately to the foreseeable effects that climate change will have on asset valuations and the liquidity and solvency of all systemically important financial institutions and their counterparts in the real economy.

But anticipating and responding appropriately to these risks now and in the future does not mean that higher capital or liquidity demands should be placed on “brown” (ie polluting) loans, bonds, and other financial instruments. The risks of financial stability and those of global warming are not perfectly correlated. Furthermore, there are no redundant instruments for financial stability policies, and liquidity and capital requirements have a clear comparative advantage when pursuing financial stability objectives, just as carbon taxes and emissions trading systems have when searching and trying. achieve “green” goals.

The crises and shocks caused by climate change will complicate the fulfillment of central banks’ price stability and financial stability mandates. The last thing they need is loading new targets onto their limited instruments.

Just as it makes no sense to use carbon taxes or emissions trading plans to promote financial stability, neither does it make sense to use liquidity and capital requirements to tackle global warming. The appropriate tools (fiscal and regulatory) to do so are well known and technically feasible. What is lacking is the foresight, the logic, and the moral courage to put them into practice.

The author

Willem H. Buiter is visiting professor of public and international affairs at Columbia University.

Translated from English by David Meléndez Tormen

Copyright: Project Syndicate, 2020

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